McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved Chapter Eighteen Consumer Loans, Credit Cards, and Real Estate Lending

18-2 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of Consumer Loans Residential Mortgage Loans Nonresidential Loans –Installment Loans –Noninstallment Loans Credit Card Loans and Revolving Credit

18-3 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Residential Mortgage Loans Credit to Finance the Purchase of Residential Property in the Form of Houses and Multifamily Dwellings. This is Usually a Long-Term Loan Which is Secured By the Property Itself

18-4 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Installment Loans Short-Term to Medium-Term Loans Repayable in Two or More Consecutive Payments, Usually Monthly or Quarterly. These Are Often Used to Finance Big Ticket Purchases or Consolidate Existing Debt.

18-5 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Noninstallment Loans Short-Term Loans By Individuals for Immediate Cash Needs and Repayable in One Lump Sum When the Borrower’s Note Matures

18-6 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Credit Card Loans Credit Cards Offer Holders Access to Either Installment or Noninstallment Credit. Banks Find That the Installment Users of Credit Cards are the Most Profitable. Banks Also Earn Discount Fees From Merchants on Credit Cards.

18-7 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Debit Cards Debit Cards Can Be Used To Pay For Goods And Services, But Not To Extend Credit. They Are A Convenient Vehicle For Making Deposits Into And Withdrawals From ATMs And They Facilitate Check Cashing.

18-8 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Characteristics of Consumer Loans Most Costly and Most Risky to Make Per Dollar Cyclically Sensitive Interest Inelastic

18-9 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Evaluating a Consumer Loan Application Character and Purpose Income Levels Deposit Balances Employment and Residential Stability Pyramiding of Debt

18-10 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Credit Bureaus Credit Reporting Agencies or Credit Bureaus Assemble and Distribute to Lenders the Credit History of Millions of Borrowers Information –Personal Identifying Data –Personal Credit Histories –Public Information That May Have Bearing on Loan

18-11 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Credit Scoring Credit Scoring Systems are Based on Sophisticated Statistical Models in Which Several Variables are Joined to Establish a Numerical Score to Separate Good Loans From Bad Loans. The Most Famous of These is the FICO Scoring System Developed by Fair Isaac.

18-12 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Laws and Regulations Applying to Consumer Loans Truth in Lending Act Fair Credit Reporting Act Fair Credit Billing Act Fair Debt Collection Practices Act Equal Credit Opportunity Act Community Reinvestment Act Home Ownership and Equity Protection Act

18-13 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Identity Theft Fastest Growing Crime Against Individuals Today It Can be Difficult to Detect and Costly to Recover From Fair Credit and Accurate Credit Transactions (FACT) Act was Passed to Counter this Growing Problem Consumers Entitled to One Free Credit Report Annually from Each of the Three Major Credit Bureaus

18-14 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Predatory Lending An Abusive Practice Among Some Lenders That Consists of Granting Loans to Weak Borrowers and Charging Them Excessive Interest Rates and Fees, Increasing the Risk of Default

18-15 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Real Estate Loans Among the Riskiest Loans Banks Can Make Average Size is Larger Than the Average Size of Other Loans Tend to Have Longer Maturities Than Other Loans

18-16 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Factors Used in Evaluating Real Estate Loans Size of Down Payment Relative to Purchase Price of Property Should Be Evaluated in Terms of Total Relationship Need to Pay Attention to Particular Aspects of Credit Application: –Amount and Stability of Income –Available Savings and Source of Down Payment –Track Record in Maintaining Property –Outlook for Real Estate Market in Local Area –Outlook for Interest Rates If Variable Rate Loan

18-17 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Home Equity Lending Home Owners Can Use the Difference in Home’s Estimated Value and Remaining Mortgages as a Borrowing Base Two Types of Credit –Closed End Credit –Lines of Credit Can Be Used for Any Legitimate Purpose The 1986 Tax Reform Act Has Helped This Type of Loan Grow in Popularity

18-18 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Interest Only Mortgages Many of these are Adjustable Rate Mortgages Home Owner Can Pay the Interest Only for an Initial Period Mortgage Payments Can be Much Higher When Principal Payments are Due Because of the Shorter Period to Repay the Loan

18-19 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Cost-Plus Model of Pricing Loans

18-20 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Annual Percentage Rate (APR) The APR is the Internal Rate of Return that Equates Total Payments With the Amount of the Loan. The Truth in Lending Act Requires That This Rate Be Disclosed to Consumers On All Loans

18-21 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Simple Interest In Simple Interest the Customer Only Pays Interest On the Amount of the Principal Left. First the Declining Loan Balance is Calculated and That Reduced Balance is Used to Calculate the Amount of Interest Owed

18-22 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Discount Rate Method The Discount Rate Method Requires the Customer to Pay the Interest in Advance. Interest is Deducted First and the Customer Receives the Loan Amount Less Any Interest Owed

18-23 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Add-On Loan Rate Method Interest Owed is Added to the Principal Amount, Then the Loan Payments are Calculated By Dividing This Sum By the Number of Loan Payments

18-24 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Rule of 78s A Rule of Thumb to Determine Exactly How Much Interest Income a Bank is Entitled to Accrue at Any Point in Time From an Installment Loan Being Paid in Monthly Installments.

18-25 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Interest Rates on Home Mortgages Fixed Rate Mortgage (FRM) – 1930s to 1970s Most Mortgages Were Fixed-Rate Mortgages. They Had a Fixed Interest Rate That Did Not Change Over the Life of the Loan Adjustable Rate Mortgage (ARM) – in the Early 1970s Adjustable Rate Mortgages Were Allowed. These Mortgages Have an Interest Rate That Changes Over the Life of the Mortgage. Roughly One Quarter of All Mortgages are Adjustable Today

18-26 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Mortgage Points This is an Additional Up Front Charge Often Required on Home Mortgages. It is a Percentage of the Loan Amount and Reduces the Amount of the Loan Available